Diamond Hill Investment : Annual Report - 2023

Diamond Hill Investment Group, Inc.

2023 Annual Report

Notice of 2024 Annual Shareholder Meeting and Proxy Statement

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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DIAMOND HILL INVESTMENT GROUP, INC.

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1

DIAMOND HILL INVESTMENT GROUP, INC.

ANNUAL LETTER TO SHAREHOLDERS

March 25, 2024

Dear Fellow Shareholders:

At Diamond Hill, we are fiercely committed to improving the lives of our clients and those they serve through the pursuit of exceptional investment results. Doing so requires discipline, patience, and a passion for what we do and who we serve. That passion drives us to develop outstanding, long-term partnerships with our clients because we know that excellent investment outcomes enable them to achieve their goals.

Achieving our long-term goals in an industry where change is constant can be challenging, especially when active managers continue to face several significant industry headwinds. Passive has been on the rise for decades - as of year-end 2023, assets in passive funds and ETFs surpassed their active counterparts. Against this backdrop, new funds launched have struggled to gain traction with only a small number reaching scale within five years. Pairing this trend with increased demand for private assets in the institutional space and increasingly in retail, traditional active managers continue to be squeezed from both sides.

And, of course, costs have been rising for asset managers - including distribution costs, growing product suites and the related data and technology to support them, operational and IT costs, and the ability to retain top investment talent to deliver strong results for clients. At the same time, rising revenues over the last 15 years have enabled a lack of cost discipline to persist within the industry. With revenues now slowing, the industry is starting to see the implications of higher cost structures.

As we look ahead, we understand the headwinds in front of us, and given our competitive advantages and our discipline to stay focused, we believe we are positioned well for long-term success. To succeed in this challenging environment over the long term, we must take market share from our competitors by delivering long-term outperformance and an exceptional client experience that differentiates us. On balance, investors are allocating more to passive products as well as to private equities and credit. Many of our competitors have pursued aggressive acquisition strategies to shift their businesses to meet that demand. The reality is that publicly traded active equity and fixed income are enormous categories that aren't going anywhere anytime soon. In our view, this environment presents opportunities for those focused on actively managing concentrated portfolios with a valuation discipline and long-term ownership mindset. As such, we remain committed to our investment philosophy and approach, and we believe we can continue to deliver highly competitive investment outcomes for our clients.

It's important to remember investors in passive products face higher investment risks than ever before. A handful of companies are now dominating US equity markets, exacerbating the already highly concentrated nature of returns. The tech-centric Magnificent 7 - Apple, Microsoft, Amazon, Alphabet, Nvidia, Meta and Tesla - accounted for more than half of 2023's returns for index-based products tracking large-cap US equities. Passive strategies, by definition, do not come with the long-term analysis or portfolio oversight of their actively managed counterparts. The winning investments become an even greater share of the index, further tilting toward added risk. Investors have been willing to make that trade-off in strong market environments, and time will tell if this imbalance is sustainable. We are convinced that active management remains an essential component of investors' success in the long run.

Instead of pursuing passive or private markets, as always, we remain focused on our strengths and prioritize areas where we have a competitive edge. While we know it will take dedication and resilience to succeed in the active strategies we've built our business on, fewer firms focused on this particular arena should further enable us to continue adding value for our clients and shareholders.

Our long-term success hinges on our ability to deliver outstanding investment performance and a differentiated client experience. Both are essential to maintain and grow enduring client partnerships. How do we do that?

We start by putting clients at the center of everything we do.

• • We align our interests with our clients' by prioritizing their investment outcomes with a commitment to develop and retain excellent investment talent and manage capacity of our strategies to protect our team's ability to deliver those outcomes.

• • We invest alongside our clients, so we understand their experiences and are there with them through the ups and downs of the market.

• • We ensure our portfolio managers are aligned with clients by looking at a long-term time horizon when evaluating their performance.

• • We competitively structure our fees to achieve a fair sharing of economics with our clients.

Our success further relies on our shared investment principles that drive not only how we think about investing but also how we think about managing our business. We take an active approach in managing concentrated portfolios we believe are well-positioned to deliver better long-term returns than benchmarks or peers. This approach depends on our valuation discipline, which is critical in how we think about the prices we pay when making investment decisions. We also consider valuation explicitly when buying back our shares and are intentional about how we return excess capital to shareholders. Our ownership mentality allows us to make the hard decisions to own investments we expect to outperform in the long run, even when those investments may not deliver strong short-term returns- and we use that same ownership mentality and long-term orientation when making decisions on how we run our business. Finally, our capacity discipline ensures we are thoughtful about how we deliver excess returns to clients.

We head into 2024 with grounded optimism. Our fixed income and international equity strategies ended the year with strong five-year and since-inception results. We finished 2023 with strong Q4 performance across many of our US equity strategies, which helped improve our rolling five-year returns - strength that has continued into Q1 2024. We have a robust pipeline of interest from clients and prospects across our fixed income and international strategies and many of our more established US equity strategies.

The Future is Bright

Our industry's challenges and headwinds are not new, and we have spent much time assessing what it will take for our business to succeed over the long run. Focusing on investment excellence and an outstanding client experience is first and foremost. Investing in areas where we have competitive advantages and modernizing our operating model to support those investments and the growth that comes with it is also significant.

Over the past several years, we have developed and implemented a strategic plan designed to guide us successfully into the next phase of our growth. In 2022, we clearly defined our strategic objectives: deliver excellent returns, thoughtfully and sustainably grow our business, and diversify across several dimensions - including diversifying our assets, clients and how we deliver our portfolios.

This strategic plan led to the appointment of a dedicated chief investment officer, Matthew Stadelman, CFA, as well as a director of research, Win Murray, over the past several years. We also elevated our focus on recruiting, developing and retaining exceptional investment talent. We added new research team members to our US equity and fixed income teams in 2023, formalized an equity track in our internship program, and recently added an assistant portfolio manager who will focus on our small-mid and mid-cap strategies to support Chris Welch, CFA.

We upgraded our distribution and marketing technologies and processes over the past five years to enhance the client experience. We built a new marketing function equipped with state-of-the-art data and analytics, and we launched a new visual identity for our brand. We also substantially advanced our adoption of technologies to nurture collaboration and connection - with an eye on delivering an employee experience that attracts and retains top talent. To ensure we can effectively execute and deliver on all of our long-term strategic initiatives going forward, we elevated Jo Ann Quinif to president of Diamond Hill Capital Management, increasing her responsibility for additional parts of our business that align with ensuring a great client experience.

We reached a significant milestone in our fixed income strategies in 2023 - assets across our fixed income strategies surpassed the $3 billion mark. As of 29 February 2024, our fixed income assets exceeded $3.9 billion. We have made significant investments to diversify our business and grow our assets, and we are pleased to see progress in this critical asset class.

In late 2023 and early 2024, we looked deeply at our operating model to assess our preparedness for the future. We believe modernizing our operating model - and understanding how the industry is changing and the impact it will have on our business - is necessary to succeed in a world increasingly driven by data and technology. Our key conclusions are that many aspects of our business serve us sufficiently today and don't need immediate change. However, there are a few areas, such as our client reporting and research management systems, as well as our approach to data architecture and governance, that we are looking to optimize over the next two years to set us up for future success.

We believe our clients choose to work with us for our investment expertise and client-centric approach. We will continue proactively seeking to offer strategies in the vehicles our clients demand and improving our ability to customize strategies to meet their needs.

As we continue to evolve our business and pursue these operational goals, there are fundamental elements of who we are as a company that will not change. Our investment principles have always been, and will always be, the foundation of who we are and how we invest. Our fundamental commitment to prioritizing client interests is a constant that forms our identity and differentiates us from others. Our core competencies focus on delivering actively managed, concentrated, long-term-oriented strategies within US and international equity and fixed income. We will remain focused on areas where we have a competitive advantage and can offer differentiated solutions.

Diamond Hill has undergone many changes since its inception. Throughout these changes, we have remained a client-centric, investment-led boutique that prioritizes a strong culture and aspires to be a great workplace. We are confident this approach will continue serving our clients and shareholders well.

Financial Results

Equity and fixed income markets were volatile in 2023, with choppy performance throughout the year. A significant portion of the year's gains came in the final two months - the MSCI All Country World Index advanced 6.75% through the end of October but finished the year with a 22.20% return. Likewise, the Bloomberg US Aggregate Bond Index, down 2.77% at the start of November, finished 2023 with a return of 5.53%, marking the best calendar year return since 2020 (+7.51%).

So, while we ended the year with total assets under management (AUM) and assets under advisement (AUA) of $29.2 billion, our average during the year was $27.3 billion, down 8% from 2022. Additionally, our mix of assets changed, partly due to fixed income inflows of $1.4 billion and equity outflows of $1.9 billion. Fixed income assets, which typically have lower fee rates, made up 14% of our AUM at the end of the year, an increase from 9% a year earlier. We recognize the impact on our business from net flows in 2023, but we are pleased with the progress we are making in adding fixed income assets.

The decline in average assets, as well as a lower average fee rate due to a shift toward lower-fee fixed income assets, resulted in a decline in revenue of 12% in 2023. We generated net operating income of $35.5 million and net operating profit margin of 26% in 2023. In managing our business, we focus on adjusted net operating income, which adjusts net operating income, as calculated in accordance with US generally accepted accounting principles (GAAP), to exclude the impact of market movements on the deferred compensation plan investments that run through net operating income, and the impact of any mutual funds that we consolidate. Adjusted net operating income was $41.4 million in 2023, down from $60.4 million in 2022, and our adjusted net operating profit margin was 30%.1 In addition to seeing the impact of inflationary pressure on many of our SG&A expenses, we manage the business with a long-term outlook and continue to make important investments in our business with that outlook in mind. The combination of the revenue decline and the investments in the business resulted in the decline in our adjusted net operating profit margin in 2023.

While 2023 was a challenging year, we focus on the long term in evaluating our results. From that perspective, we ended the year more positively than it began. The late-year rally boosted our ending AUM and AUA above $29 billion, more than $2.5 billion higher than where we started the year. Additionally, the strong market returns generated $23 million in investment

1 Adjusted net operating income and adjusted net operating profit margin are non-GAAP financial measures. See the Annex to this letter for a reconciliation of non-GAAP financial measures to the most directly comparable financial measures calculated and presented in accordance with GAAP.

income in 2023. Our net income attributable to common shareholders was $42.2 million, up from $40.4 million in 2022, and our earnings per share increased to $14.32 from $13.01 in the prior year.

Capital Allocation

Our capital allocation approach is designed to grow the intrinsic value of the business by investing in new and existing strategies and ensuring we have sufficient capital to operate the business in any market environment. When we believe we have more capital than is necessary to achieve those aims, we return capital to shareholders. Our approach has evolved over our history as we have deployed new methods of returning capital. Beginning in 2018, we began repurchasing shares for the first time. In 2021, we implemented our first regular quarterly dividend.

We may repurchase shares when they are trading below our estimate of the firm's intrinsic value. Since we began repurchasing shares in 2018, we have repurchased approximately 954,000 shares totaling $146 million, representing approximately 27% of our shares outstanding when we initiated our repurchases. Those repurchases have been partially offset by the net issuance of approximately 245,000 shares in the form of compensation to our associates over that period. We believe share-based compensation is a meaningful way to align our interests with shareholders. Since 2018, we have reduced our total share count by 711,000 shares, or 20%. Share repurchases in 2023 were approximately 213,000 shares, totaling $34.6 million.

After considering strategic uses of capital and share repurchases, we evaluate any excess capital to pay dividends. In 2023, we paid shareholders a $1.50 per share regular quarterly dividend, totaling $6.00 per share, or approximately $17.7 million. We have paid dividends for 16 consecutive years, cumulatively totaling $139.00 per share.

Each year, we will continue to consider paying a special dividend in Q4 after assessing our strategic capital deployment and share repurchases during the year. In 2023, we determined not to pay a special dividend in Q4 given the large capital return via share repurchases as well as our regular quarterly dividends during the year, which combined totaled $52.5 million.

Conclusion

While Jim Laird will continue as a board member through the end of his term in 2025, effective February 29, 2024, he has stepped down from his role as chairman. We are grateful to Jim for his leadership over the years and his many contributions to our success, first as Diamond Hill's chief financial officer and president of Diamond Hill Funds from 2001 to 2014, as a director on our board since 2011 and as chairman since 2019.

We believe the best way to generate strong long-term shareholder returns is to deliver excellent investment outcomes for our clients. Our investment team is intensely focused on generating alpha for our clients, and our entire firm is committed to developing and maintaining partnerships that help instill the confidence required to remain invested through complete market cycles. This perspective has enabled us to grow new and existing client relationships, which ultimately helps us deliver returns to our shareholders.

Sincerely,

Heather Brilliant

Chief Executive Officer and President

ANNEX - RECONCILIATION OF NON-GAAP MEASURES

As a supplement to information calculated and presented in accordance with U.S. generally accepted accounting principles ("GAAP"), Diamond Hill Investment Group, Inc. (the "Company") is providing certain financial measures that are based on methodologies other than GAAP ("non-GAAP"). Management believes the non-GAAP financial measures below are useful measures of the Company's core business activities, are important metrics in estimating the value of an asset management business, and help facilitate comparisons to Company operating performance across periods. These non-GAAP financial measures should not be used as a substitute for financial measures calculated in accordance with GAAP and may be calculated differently by other companies. The following schedules reconcile the difference between financial measures calculated in accordance with GAAP and non-GAAP financial measures for the years ended December 31, 2023 and 2022, respectively.

Year Ended December 31, 2023

Earnings per

share

(in thousands, except percentages and per share data)

Total operating expensesNet operating incomeTotal non-operating incomeIncome tax expense(5)Net income attributable to common shareholdersattributable to common shareholders - dilutedNet operating profit margin

$

101,212

$

35,504

• $ 23,071

$

15,490

$

42,226

$

14.32

26 %

GAAP Basis Non-GAAP Adjustments:

Deferred compensation liability(1)

(5,600)

Consolidated Funds(2)

Other investment income(4)

$

• (13,323) (3,571)

(9,752)

(3.31)

- -

5,600 330 -

(5,600) (4,148)

- (793)

- (2,166)

- (0.73)

4 % - -

Adjusted Non-GAAP Basis

$

95,612

$

41,434

-

$

11,126

$

30,308

$

10.28

30 %

Year Ended December 31, 2022

(in thousands, except percentages and per share data)

Total operating expensesNet operating incomeTotal non-operating lossIncome tax expense(5)Net income attributable to common shareholdersEarnings per share attributable to common shareholders - dilutedNet operating profit margin

$

• 90,165 $

64,331

• $ (13,373) $

  14,088

  $

  40,434

  $

  13.01

  42 %

• GAAP Basis Non-GAAP Adjustments: Deferred compensation liability(1)

  Consolidated Funds(2)

  4,402 -

  (4,402)

  423

  4,402 11,317

  - 2,113

  - 6,063

  - 1.95

  (3)% -

  Gain on sale of High Yield-Focused Advisory Contracts(3)

  (6,814)

  (1,761)

  (5,053)

  (1.63)

  Other investment income(4)

  - -

  - -

• $ 4,468

1,155

3,313

1.07

- -

Adjusted Non-GAAP Basis

$

94,567

$

60,352

-

$

15,595

$

44,757

$

14.40

39 %

(1) This non-GAAP adjustment removes the compensation expense resulting from market valuation changes in the Diamond Hill Fixed Term Deferred Compensation Plan and the Diamond Hill Variable Term Deferred Compensation Plan's (together, the "Deferred Compensation Plans") liability and the related net gains or losses on investments designated as an economic hedge against the related liability. Amounts deferred under the Deferred Compensation Plans are adjusted for appreciation/ depreciation of investments chosen by participants. The Company believes it is useful to offset the non-operating investment income or loss realized on the hedges against the related compensation expense and remove the net impact to help readers understand the Company's core operating results and to improve comparability from period to period.

(2) This non-GAAP adjustment removes the impact that the Diamond Hill International Fund and the Diamond Hill Large Cap Concentrated Fund (during a period for which such fund is or such funds are consolidated, the "Consolidated Funds") have on the Company's GAAP consolidated statements of income. Specifically, the Company adds back the operating expenses and subtracts the investment income of the Consolidated Funds. The adjustment to net operating income represents the operating expenses of the Consolidated Funds, net of the elimination of related management and administrative fees. The adjustment to net income attributable to common shareholders represents the net income of the Consolidated Funds, net of redeemable non-controlling interests. The Company believes removing the impact of the Consolidated Funds helps readers understand its core operating results and improves comparability from period to period.

(3) This non-GAAP adjustment removes the impact of the gain on the sale of the Diamond Hill Corporate Credit and the Diamond Hill High Yield investment advisory contracts (together, the "High Yield-Focused Advisory Contracts") to Brandywine Global Investment Management, LLC effective July 30, 2021. The sale of the High Yield-Focused Advisory Contracts was a discrete transaction; thus, the Company believes that removing the impact of the gain helps readers understand the Company's core operating results and improves comparability from period to period.

(4) This non-GAAP adjustment represents the net gains or losses earned on the Company's non-consolidated investment portfolio that are not designated as economic hedges of the Deferred Compensation Plans' liability, non-consolidated seed investments, and other investments. The Company believes adjusting for these non-operating income or loss items helps readers understand the Company's core operating results and improves comparability from period to period.

(5) The income tax expense impacts were calculated and resulted in an overall non-GAAP effective tax rate of 26.8% for 2023 and 25.8% for 2022.

Diamond Hill Investment Group, Inc. 325 John H. McConnell Boulevard, Suite 200

Columbus, Ohio 43215

March 25, 2024

Dear Shareholders:

We cordially invite you to attend the 2024 Annual Meeting of Shareholders of Diamond Hill Investment Group, Inc., to be held at Diamond Hill Investment Group, Inc., 325 John H. McConnell Boulevard, Suite 125, Columbus, Ohio 43215, on Thursday, May 9, 2024 at 10:00 a.m. Eastern Time.

The attached Notice of Annual Meeting and Proxy Statement describe the formal business to be transacted at the meeting. Immediately following the meeting, we will hold a management presentation to report on our operations, and our directors and officers will be present to respond to any appropriate questions you may have. For the management presentation only, there will be the option to participate virtually, and the link will be made available on our website, ir.diamond-hill.com.

On behalf of the Board of Directors, we urge you to sign, date, and return the enclosed proxy card as soon as possible, even if you plan to attend the Annual Meeting. Returning the enclosed proxy card will not prevent you from voting in person, but it will ensure that your vote is counted if you are unable to attend the Annual Meeting. Your vote is important, regardless of the number of shares you own.

Sincerely,

Heather E. Brilliant

Chief Executive Officer and President

Diamond Hill Investment Group, Inc.

325 John H. McConnell Boulevard, Suite 200, Columbus, Ohio 43215

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

TO BE HELD ON MAY 9, 2024

Notice is hereby given that the 2024 Annual Meeting of Shareholders (the "Annual Meeting") of Diamond Hill Investment Group, Inc. (the "Company") will be held at Diamond Hill Investment Group, Inc., 325 John H. McConnell Boulevard, Suite 125, Columbus, Ohio 43215, on Thursday, May 9, 2024 at 10:00 a.m. Eastern Time, to consider and act upon the following matters:

• 1) The election of six directors to serve on the Company's Board of Directors ("Board") until the Company's 2025

  Annual Meeting of Shareholders and until their successors have been duly elected and qualified;

• 2) The ratification of the appointment of KPMG LLP as the Company's independent registered public accounting firm for the fiscal year ending December 31, 2024;

• 3) An advisory resolution to approve the 2023 compensation of the Company's named executive officers; and

• 4) Such other business as may properly come before the Annual Meeting or any adjournment thereof.

Action may be taken on the foregoing proposals at the Annual Meeting or at any postponement or adjournment of the Annual Meeting. The Board has fixed the close of business on March 11, 2024, as the record date for determining the shareholders entitled to vote at the Annual Meeting and any postponements or adjournments thereof. On or about March 25, 2024, the Company began mailing to shareholders of record as of the close of business on March 11, 2024, the accompanying Proxy Statement, the form of proxy (also known as a proxy card), and the Company's 2023 Annual Report to shareholders.

PROMPTLY RETURNING YOUR PROXY CARD WILL SAVE THE COMPANY THE EXPENSE OF MAKING FURTHER REQUESTS FOR PROXIES IN ORDER TO OBTAIN A QUORUM. WHETHER OR NOT YOU PLAN TO ATTEND THE ANNUAL MEETING, PLEASE COMPLETE, SIGN, DATE, AND RETURN THE ENCLOSED PROXY CARD IN THE ENCLOSED POSTAGE-PAID ENVELOPE. ALTERNATIVELY, REFER TO THE INSTRUCTIONS ON THE PROXY CARD TO TRANSMIT YOUR VOTING INSTRUCTIONS VIA THE INTERNET OR BY TELEPHONE. IF YOU ATTEND THE ANNUAL MEETING, YOU MAY REVOKE YOUR PREVIOUSLY SUBMITTED PROXY AND VOTE IN PERSON AS DESCRIBED IN THE PROXY STATEMENT.

By order of the Board,

Carlotta D. King, Secretary

Columbus, Ohio

March 25, 2024

IMPORTANT NOTICE REGARDING THE AVAILABILITY OF PROXY MATERIALS FOR THE

ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON MAY 9, 2024:

The Proxy Statement and the Company's 2023 Annual Report on Form 10-K are available without charge at the following location:https://ir.diamond-hill.com/sec-filings-ownership/proxy-materials/